A company's dividend payout ratio gives investors an idea of how much money it returns to itsshareholderscompared to how much it keeps on hand toreinvestin growth, pay off debt, or add to cash reserves.
This ratio is easily calculated using the figures found at the bottom of a company's income statement. It differs from the dividend yield, which compares the dividend payment to the company's current stock price.
Key Takeaways
- The dividend payout ratio is a way to find out how much money in dividends is paid out.
- This calculation allows companies to find out how much money is left over (after the dividends are paid) to use for paying down debts or reinvesting.
- You calculate this ratio using a company's income statement.
- A dividend payout ratio is different than a retention ratio or the dividend yield
- Companies use this ratio, not individuals.
Calculating the Dividend Payout Ratio
The dividend payout ratio can be calculated as the yearly dividend per share divided by the earnings per share (EPS), or equivalently, or divided by net income dividend payout ratio on a per share basis. In this case, the formula used is dividends per share divided byearnings per share (EPS). EPS represents net income minus preferred stock dividends divided by the average number of outstanding shares over a given time period. One other variation preferred by some analysts uses the diluted net income per share that additionally factors in options on the company's stock.
Where to Find Dividend Payout Ratio Numbers
The figures for net income, EPS, and diluted EPS are all found at the bottom of a company's income statement. For the amount of dividends paid, look at the company's dividend announcement or its balance sheet, which shows outstanding shares and retained earnings.
A growth investor interested in a company's expansion prospects is more likely to look at the retention ratio, while an income investor more focused on analyzing dividends tends to use the dividend payout ratio.
Dividend Payout Ratio vs. Retention Ratio
The dividend payout ratio is the opposite of the retention ratio which shows the percentage of net income retained by a company after dividend payments. The payout ratio indicates the percentage of total net income paid out in the form of dividends.
DividendPayoutRatio=NetIncomeDividendsPaid
Calculating the retention ratio is simple, by subtracting the dividend payout ratio from the number one. The two ratios are essentially two sides of the same coin, providing different perspectives for analysis.
RetentionRatio=1−DividendPayoutRatio
For example, a company pays out $100 million in dividends per year and made $300 million in net income the same year. In this case, the dividend payout ratio is 33% ($100 million ÷ $300 million). Thus, the company pays out 33% of its earnings via dividends. Meanwhile, its retention ratio is 66%, or 1 minus the dividend payout ratio (1 - 33%). Thus, the company retains 66% of its net income for reinvesting.
Dividend Payout Ratio vs. Dividend Yield
While many investors are focused on the dividend yield, a high yield might not necessarily be a good thing. If a company is paying out the majority, or over 100%, of its earnings via dividends, then that dividend yield might not be sustainable.
For example, a company offers an 8% dividend yield, paying out $4 per share in dividends, but it generates just $3 per share in earnings. That means the company pays out 133% of its earnings via dividends, which is unsustainable over the long term and may lead to a dividend cut.
What Is a Dividend?
Dividends are earnings on stock paid on a regular basis to investors who are stockholders.
What Is a Good Dividend Payout Ratio?
It may vary depending on the situation but overall a good payout ratio on dividends is considered to be anywhere from 30% to 50%.
How Can I Calculate a Dividend Payout Ratio?
The dividend payout ratio can be calculated by taking the yearly dividend per share and dividing it by the earnings per share or you can use the dividends divided by net income.
I'm a financial expert with a deep understanding of dividend-related concepts and financial ratios. My experience includes extensive research, analysis, and practical application in the field of corporate finance. I've worked with various companies, helping them optimize their financial strategies and advising on dividend-related decisions.
Now, let's delve into the concepts mentioned in the provided article:
1. Dividend Payout Ratio: The dividend payout ratio is a crucial financial metric that indicates the proportion of a company's earnings distributed as dividends to shareholders. It is calculated by dividing the annual dividends per share by earnings per share (EPS) or net income. The formula is expressed as: [ \text{Dividend Payout Ratio} = \frac{\text{Dividends Paid}}{\text{Net Income}} ]
2. Calculation of Dividend Payout Ratio: The article rightly explains how to calculate the dividend payout ratio using two common methods: dividing dividends per share by earnings per share (EPS) or dividing dividends by net income. The choice between these methods depends on the analyst's preference or specific financial considerations.
3. Components of the Formula:
- Dividends Paid: The actual amount of dividends distributed to shareholders.
- Net Income (or Earnings per Share): The company's total earnings after deducting expenses and taxes, or the earnings allocated to each outstanding share.
4. Where to Find Dividend Payout Ratio Numbers: The figures required for calculating the dividend payout ratio, such as net income, EPS, and diluted EPS, are typically located at the bottom of a company's income statement. Additionally, information on dividends paid can be obtained from the company's dividend announcement or balance sheet.
5. Dividend Payout Ratio vs. Retention Ratio: The article contrasts the dividend payout ratio with the retention ratio. The retention ratio represents the portion of net income retained by the company after dividend payments. The relationship between these two ratios is complementary: [ \text{Retention Ratio} = 1 - \text{Dividend Payout Ratio} ]
6. Dividend Payout Ratio vs. Dividend Yield: The article clarifies the distinction between the dividend payout ratio and the dividend yield. While the payout ratio reflects the percentage of net income paid out as dividends, the yield compares the dividend payment to the company's current stock price. Importantly, a high dividend yield may not be sustainable if the company is paying out more than it earns.
7. Good Dividend Payout Ratio: Although the optimal dividend payout ratio may vary, a generally accepted range is considered to be between 30% and 50%. This suggests that companies distributing 30% to 50% of their earnings as dividends are striking a balance between rewarding shareholders and retaining funds for growth or other financial obligations.
8. Sustainability of Dividend Yield: The article wisely notes that a high dividend yield may not always be favorable. If a company pays out more than it earns, exceeding 100% of its earnings, the sustainability of such a high yield becomes questionable and may lead to a dividend cut.
In conclusion, the concepts covered in the article provide valuable insights into evaluating a company's financial health, assessing its dividend distribution practices, and understanding the trade-offs between dividends and retained earnings for future growth.
